Related Articles

It is commonly thought that increases or decreases in the prime rate published in the paper will automatically translate into changes in mortgage interest rates. Consumers find it hard to understand when prime rates go down and mortgage rates stay the same. While lenders are ready to use an increase in prime or Federal Reserve rates as an excuse to increase mortgage interest rates, the truth is that since the 1980s, mortgage interest rates have little to nothing to do with Federal Reserve rates and more to do with the profit motives of Wall Street investors.

History

Until deregulation in the early 1980s, savings and loans (S&Ls;) were the only entities allowed to make mortgage loans. Commercial loans were the domain of banks. Savings and loans funded their mortgages by using the money of their depositors and by borrowing from other banks or the Federal Reserve Bank. The law required S&Ls; to keep a certain percentage of their deposits on hand, so they would borrow money at one rate and lend it out at a higher rate to make a profit, to keep operating and to pay interest to their depositors. Since they relied on bank and Federal Reserve money, the rates the S&Ls; were charged directly influenced the rate they charged their borrowers.

Secondary Mortgage Market

Deregulation in the 1980s allowed banks and other entities to enter the mortgage market and changed the funding of mortgages. The secondary mortgage market began to play a much greater role. At first, the secondary mortgage market was controlled by the government-sponsored entities of Freddie Mac and Fannie Mae (for conventional loans) and Ginnie Mae (for government-backed loans such as those insured by the FHA and VA). These entities bought loans from mortgage loan originators, bundled them and guaranteed their rate of return, then sold them on the open market to investors.

Effects

Eventually, this practice became so widespread and such an integral part of the mortgage business that private companies began buying mortgages and operating in the secondary mortgage market. Loan originators had only to lend the money out for a few weeks or months before they could sell the loan and get their money back. This allowed lenders to turn around and lend money to the next borrower and gave them a continuous source of funds.

Significance

Since money borrowed from banks and the Federal Reserve system was no longer necessary for mortgage funding, the amount of money these groups were charging as interest became irrelevant. Secondary mortgage companies and investors were now the main source of mortgage funds. The return investors demanded in the open secondary mortgage market now determined how much it cost loan originators to get funds. Loan originators took this rate of return, added their profit to it and charged that compounded rate to their borrowers. This has been the norm since the 1990s.

Result

There is no hard and fast way to determine mortgage interest rates, given the scope of the secondary mortgage market. It is a very complex process. Mortgage securities, which are the bundled loans sold on the secondary market, are long-term investments. The investors in long-term investments are typically those who are looking for secure but steady sources of profits, like pension funds or insurance companies. These investors also buy bonds, blue chip stocks and other stable investments, so returns on mortgage securities have to be competitive with these types of investments. If you watched all of these long-term investments over time, you could probably get an idea of where rates will be based on their rates of returns. Investors demand larger returns on riskier loans, so the weaker your credit and income, and the lower your down payment, the higher the interest rate your lender will charge you.